American investors in European stocks and bonds experienced a bad case of deja vu last week: European markets plunged on growing fears that interest rates there have bottomed.
Earlier this year, it took an actual boost in short-term rates by the Federal Reserve Board to send U.S. stocks reeling. In Europe, all it took last week was for German central bank President Hans Tietmeyer to suggest that the Bundesbank may be finished cutting short rates for now.
Mindful of Germany's still-languishing economy, Tietmeyer said nothing about raising rates. Yet investors reacted with horror at the thought that European short rates might stop falling, after only 20 months of Bundesbank-led cuts. At about 5% now, the yield on 3-month German treasury bills is well above the 4.25% yield on U.S. T-bills--even though Germany's economy is weak while the U.S. economy is strong.
Rattled by Tietmeyer, the Frankfurt stock market's DAX index slumped 109 points for the week, to 2,140.99 Friday--a drop of 4.8%, or the equivalent of the Dow industrial index losing 180 points from its current 3,757.14.
Because the Bundesbank largely calls the tune for interest rates across Europe, most of the region's other stock markets also went down hard. In London, the FTSE-100 stock index tumbled 5.1% for the week; Milan's Mibtel index dove 5.9%.
Worse, in some respects, was the reaction in European bond markets to Tietmeyer's comments. In Britain, the yield on the benchmark 15-year government bond closed at 8.50% Friday, up from 8.18% just three days earlier.
But while investors were dumping European securities, other world markets paid scant attention. In fact, North American, South American and Asian stock markets generally finished higher last week or unchanged.
Other markets' ability to ignore Europe's turmoil may be a sign that international investing has become a stock-picker's game again--unlike last year, when virtually all foreign markets rocketed.
As markets go their separate ways, U.S. investors will find international investing more challenging, but also potentially more rewarding. If you can recognize bargains among individual markets, or you're in a foreign mutual fund that has proved its savvy as a global stock-picker, you should earn above-average returns.
So far in 1994, a good defense has been the best offense in foreign investing. Early this year, the smart money was selling stocks in Hong Kong, Singapore, Bangkok and other Southeast Asian markets after their 60%-plus gains in 1993. Those markets began to dive in January, and only recently have they shown signs of bottoming.
Meanwhile, the Japanese stock market has been this year's big surprise. The Nikkei index has jumped 19.3% year-to-date, fueled by the perception that Japan's economy is bottoming after three difficult years.
Until last week, European stock markets had held the middle ground between Southeast Asian markets' plunge and Japan's hot streak. Most European markets were off marginally for the year, though with the dollar's weakness American investors still were making money there.
Does last week's selloff suggest European stocks are poised for a meltdown? Many international stock fund managers don't think so. For the most part, fund managers still believe there's room for short- and long-term European interest rates to fall, because the Continent's economy is only beginning to emerge from recession.
On Friday, in fact, the Bundesbank's Tietmeyer tried to allay investors' fears by telling a radio interviewer in Germany that "it can be taken for granted" that the Bundesbank will keep cutting money market rates, even if it makes no additional cuts in its official discount rate.
But European stocks now face other obstacles, fund managers admit. John Hickling, who runs the Boston-based Fidelity Overseas fund, says too many European firms are trying to raise money with new stock offerings. "There's supply coming from everywhere," he warns.
Political risk is also high, with German elections looming this year. Pressure on politicians in Germany (and across Europe) to use government spending to bring down double-digit unemployment rates may keep inflation concerns at the forefront, in turn keeping bond yields artificially steep.
Lastly, there's the issue of valuation: Many European markets look expensive because corporate earnings remain depressed while stocks have rallied since 1992.
Nonetheless, European stock bulls expect their markets to follow the U.S. script: As the economy improves, the bulls see investors flocking back to European industrial stocks, which have the most to gain from an economic turnaround.
For example, Hickling's fund has about half its assets in Europe, mainly in industrial giants such as auto makers Volvo and Peugeot, and energy/petrochemical leaders such as Elf Aquitaine and Total.
Madelynn Matlock, manager of the Bartlett Value International fund in Cincinnati, has 59% of her fund's asset in Europe. She expects investors to eventually return to such industrial names as Tampella, a Finnish maker of mining equipment, and to French construction materials firm Saint Gobain.
Jeff Russell, co-manager of the Smith Barney International Equity fund in New York, argues that European stocks still don't reflect the future earnings benefit from corporate restructurings still in full swing there--a couple years behind the U.S. restructuring binge.
His fund, about 45% invested in Europe, has targeted stocks in Italy, Ireland and other countries that depreciated their currencies 18 months ago. That depreciation made those countries' exports more competitive, giving their companies a head start in Europe's recovery, Russell says.
But some international stock fund managers contend that the best place to put new money to work today isn't Europe, but the beaten-down emerging markets of Asia and Latin America.
Norman Kurland, head of Pioneer International Growth fund in Boston, is only 35% invested in Europe. He finds more allure in markets such as Mexico, South Korea and Thailand, especially after their selloffs this year.
If you want to bet on global growth, Kurland argues, it makes more sense to invest now in Asia or Latin America.
Expansions in the United States and Europe, he says, will be magnified in already-booming emerging economies that are major exporters to the developed world. And emerging markets' stock valuations are once again reasonable, he says.
Comparing World Markets
How key world stock markets performed last week, and their year-to-date performances. Also included is each market's price-to-earnings (P-E) ratio, based on estimated 1994 earnings, and price-to-book value, which measures stock prices as a multiple of underlying asset value. Stock indexes used are the principal indexes in each country, measured in local currency; P-Es and price-to-book are Morgan Stanley estimates.
Key stock index chng.: P-E on Price to Market Last week '94 to date '94 est. book value Mexico +2.8% -4.5% 14 2.3 Japan +2.1% +19.3% 72 2.2 Canada +0.7% +0.2% 43 1.7 United States +0.5% -2.0% 18 2.6 Argentina +0.4% +2.7% 16 2.8 Korea +0.4% +9.9% 17 1.3 Australia -0.1% -3.3% 15 1.7 Malaysia -0.1% -21.6% 25 3.8 Hong Kong -1.7% -20.3% 12 2.0 Spain -2.2% +2.5% 17 1.4 Germany -4.8% -5.5% 54 2.3 France -4.9% -9.6% 26 1.7 Britain -5.1% -13.2% 17 2.3 Italy -5.9% +16.3% 32 1.8
Source: Morgan Stanley Capital Intl.; Times research